For more than 30 years, Jules Kroll ran an international company that investigates, among other things, financial fraud and corruption for foreign governments and corporations. Digging up information on embarrassing problems that can lead to scandal, lawsuits and ultimately lost revenues was his specialty.
Kroll sold the company for more than $1 billion. Now, the 68-year-old plans to take his investigative expertise and apply it to creating a credit rating agency.
"I saw this as another version of due diligence," Kroll says. "You really look hard at what the underlying facts are, and then you rate them, which is what we've done for years but in a different context."
Credit rating agencies are under scrutiny for giving their highest ratings to bonds full of risky subprime loans that ultimately failed. With their reputations seriously damaged, there's an opportunity for other firms to compete with Moody's, Fitch and Standard & Poor's, the top three that dominate the market.
Scrutiny Of Lending Terms
Kroll says his rating agency -- Kroll Bond Ratings Inc. -- won't just rely on the arithmetic modeling that the big three utilize. Instead, he says, his bond raters will look at the lending terms of the actual mortgages being packaged and do physical inspections of a sampling of properties -- the kinds of things he says these firms failed to do.
"There has been virtually no skepticism, virtually no fact-finding," Kroll says. "It has been the acceptance of what's presented by the people seeking to raise the money."
Those seeking to raise the money are financial institutions such as Goldman Sachs, Morgan Stanley and others. New York's attorney general is investigating whether the firms misled the credit rating agencies.
While the reputations of credit rating agencies are getting badly damaged, it's investors like pension funds and other institutions that have lost billions of dollars -- a fact Kroll is keenly aware of:
"It's really time for the investment institutions to take charge of their own destiny," he says.
Outreach To Pension Funds
He's been soliciting them and expects pension funds in particular to own up to 40 percent of his company -- giving them substantial power over how ratings are conducted.
"They owe it to themselves," Kroll says." They owe it to the people whose money they are managing."
Kroll says he'll try to get 20 pension funds to sign on with him by the end of the year. The California Public Employees' Retirement System (CalPERS) wouldn't comment on whether it's interested in Kroll. But it did make clear that the institution feels duped by credit rating agencies.
CalPERS is suing Moody's, Fitch and Standard & Poor's claiming they helped structure three investments that ended up collapsing despite having AAA ratings. Hundreds of millions of dollars were lost in those investments.
In press reports, Standard & Poor's and Fitch have both called CalPERS claims baseless and without merit.
Credit rating agencies stand accused of giving into financial firms that were threatening to take their business elsewhere if they didn't receive desirable ratings.
"The issuers did make those kinds of threats," says Lawrence White, an economics professor at New York University's Stern School of Business. "There was shopping around going on, and the rating firms succumbed."
White says that increasing competition among credit rating agencies is the key to reforming the current system. And once there are more options, he says, the markets will decide who has the most accurate ratings.
Kroll plans to release his first ratings in July.